An overview of

financial management

Dr. Mu’izzuddin
muizzudin@unsri.ac.id
What is finance?

• Finance vs. Economic and Accounting

Economics --------.-------- Accounting

• Finance within an organization
• Corporate finance, Capital Markets, and
Investments

.) Finance
Financial management; meaning, objectives, and
functions

• FM: planning, organizing,

directing and controlling Example:
the financial activities. You are planning to take a business loan to purchase a
new space for your business office. – Here it is advisable
• Scope/elements: to take a real estate advisor and you need to check
investment decisions, whether the valuation after 20 years or more will be higher
than renting it or not. Also, you need to consult financial
financial decisions, and department whether investing 20% of funds in down
payment and taking 80% business loan will give good
dividend decisions. returns on investment or not. Many times, there are cases
where, renting can be more economical than purchasing,
regardless of whether you’re leasing a property, software
or renting a vehicle.
Balance sheet model to understand the
responsibility of financial managers
Assets Liabilities
Current assets Current liabilities
Fixed assets Long-term debt
Stockholders’ equity

Current assets Current liabilities

Long-term debt
Fixed assets Stockholders’ equity

Investment decisions Funding decisions

looking for investment with the highest looking for funds with the lowest cost
return
Working capital decisions
invest in optimal working capital Modified from
Hanafi, M.M. (2004)
maximizing firm value
Creating shareholder value through increasing
cash flow
• Positive cash inflow
• Cash inflow vs. accounting profit
Accounting profit Cash flow
Sales 1,000,000 1,000,000
Operating expenses 500,000 (500,000)
Depreciation 200,000 -
Gross profit 300,000 -
Taxes 120,000 (120,000)
180,000 380,000

• Magnitude, timing, and risk

Is stock price
maximization the same
as profit maximization?
• No, despite a generally high correlation
amongst stock price, EPS, and cash flow.
• Current stock price relies upon current
earnings, as well as future earnings and cash
flow.
• Some actions may cause an increase in earnings
yet cause the stock price to decrease (and vice
versa).
Factors that affect stock price

• Projected cash flows to shareholders

• Timing of the cash flow stream
• Riskiness of the cash flows
Sarbanes Oxley Act (SOX)

• If the firm is publicly owned, the CEO and the

CFO must both certify to the Securities and
Exchange Commission (SEC) that reports
released to stockholders, and especially the
annual report, are accurate.
• This requirement was instituted in 2002 as a Source: What is SOX Compliance?, https://www.dnsstuff.com/what-is-sox-compliance

part of the Sarbanes-Oxley Act.

Enrol Scandal

• At Enron's peak, its shares were worth • Several of Enron's executives were charged
$90.75; just prior to declaring bankruptcy with conspiracy, insider trading, and
on Dec. 2, 2001, they were trading at securities fraud.
$0.26.1
• Fake holdings and off-the-books
accounting.
Corporate Finance

• Financial management (corporate finance) focuses on decisions

relating to how much and what types of assets to acquire, how to
raise the capital needed to buy assets, and how to run the firm to
maximize its value;

Source: Corporate Finance Overview,

https://corporatefinanceinstitute.com/resources/knowledge/finance/corporate-finance-industry/
Capital Market

• Relate to the markets where interest rates, along

with stock and bond prices, are determined.
• Also studied here are the financial institutions
that supply capital to businesses.

Further explanation on the capital market can be

found in Tandelilin, E. (2017)
 Security analysis deals with finding the proper
values of individual securities (i.e., stocks and
bonds).

Investment Portfolio theory deals with the best way to

structure portfolios, or “baskets,” of stocks and
bonds.

Behavioral finance, where investor psychology is

examined to determine if stock prices have been
bid up to unreasonable heights in a speculative
bubble or driven down to unreasonable lows in a
fit of irrational pessimism, is a part of market
analysis.
Stock prices and shareholder value
• The primary goal of a corporation should be to maximize its
owners’ value, but a proprietor’s goal might be quite different.

Example:

The proprietor CEO of a large corporation

of a local sporting goods store
Agency conflict

• An agency relationship arises whenever one or more individuals,

called principals, (1) hires another individual or organization, called
an agent, to perform some service and (2) then delegates decision-
making authority to that agent.
• Within a corporation, agency relationships exist between:
• Shareholders and managers
• Shareholders and creditors
Shareholders vs. Manager
• Managers are naturally inclined to act in their own best interests.
• But the following factors affect managerial behavior:
• Managerial compensation plans
• Direct intervention by shareholders
• The threat of firing
• The threat of takeover
Shareholders vs. Creditors

• Shareholders (through managers) could take actions to maximize

stock price that are detrimental to creditors.
• In the long run, such actions will raise the cost of debt and
ultimately lower stock price.
Majority and minority shareholders
Minority
shareholders (30%)

PT X buy PT Y

Majority
shareholders (70%)

Asset market price of PT Y: Rp 1,000,000

Acquisition purchase price: Rp 200,000 Modified from
Hanafi, M.M. (2004)
The Set-of-Contracts Perspective

• The firm can be viewed as a set of contracts.

• One of these contracts is between shareholders and managers.
• The managers will usually act in the shareholders’ interests.
• The shareholders can devise contracts that align the incentives
of the managers with the goals of the shareholders.
• The shareholders can monitor the managers behavior.
• This contracting and monitoring is costly.
Managerial goals

• Managerial goals may be different from shareholder goals

• Expensive perquisites
• Survival
• Independence
• Increased growth and size are not necessarily the same thing as
increased shareholder wealth.
Separation of Ownership and Control

Board of Directors

Debtholders

Shareholders
Management

Debt
Assets
Equity
Financial Markets

• Primary Market
• When a corporation issues securities, cash flows from investors to the firm.
• Usually an underwriter is involved
• Secondary Markets
• Involve the sale of “used” securities from one investor to another.
• Securities may be exchange traded or trade over-the-counter in a dealer
market.
Financial Markets

Stocks and
Investors
Bonds
Firms securities
Money Bob Sue
money

Primary Market
Secondary
Market
Basic Valuation Model
CF1 CF2 CFn
Value = 1
+ 2
++
(1 + k) (1 + k) (1 + k) n
n
CFt
= t
.
t =1 (1 + k)

• To estimate an asset’s value, one estimates the cash flow

for each period t (CFt), the life of the asset (n), and the
appropriate discount rate (k)
• Throughout the course, we discuss how to estimate the
inputs and how financial management is used to improve
them and thus maximize a firm’s value.
 Thankyou

muizzudin@unsri.ac.id